a. Describe what is meant by the term book income? Which number in ZAGG’s statement of operation captures this notion for fiscal 2012? Describe how a company’s book income differs from its taxable income.
BOOK INCOME: the income reported within the financial statements of the taxable entity. For example, taxable income normally is not aligned with the financial income (book income) reported within financial statements(Ventureline.com). In other words, the net income shown is the book income. The number on the statement of operations for fiscal 2012 is $14,505 (in thousands). The gap between book and tax income
generally results from three categories of differences: temporary, permanent, and loss carryforwards/carrybacks(dummies.com).
b. In your own words, define the following terms:
i. Permanent tax differences: “results from items that enter into pretax financial income but never into taxable income or enter into taxable income but never into pretax financial income” (Kieso,Weygandt,Warfield). “An example is if a company reported pretax financial income of $200,000 in each of the years 2015, 2016, 2017. The company is subject to a 30 percent tax rate and has the following difference: Bio-Tech reports gross profit of $18,000 from an installment sale in 2015 for tax purposes over an 18-month period at a constant amount per month beginning January 1, 2016. It
recognizes the entire amount for book purposes in 2015” (Kieso,Weygandt,Warfield).
ii. Temporary tax difference: “Temporary (or timing) differences between book income versus taxable income are due to items of revenue or expense that are
recognized in one period for taxes, but in a different period for the books. Book
recognition can come before or after tax recognition. These revenue and expense items cause a timing difference between the two incomes, but over the "long run", they cause no difference between the two incomes” (Investopedia.com). Two examples are: “(1) the calculation of depreciation expense by means of the straight-line method for books and by means of an accelerated method for taxes, and (2) the calculation of bad-debts expense by means of the allowance method for books and by means of the direct write- off method for taxes” (Investopedia.com).
iii. Statutory tax rate: “The statutory tax rate is the tax imposed by law (by
“statute,” hence the name). This is expressed as some percentage” (deanebarker.net).
The statutory tax is a required tax that is imposed by federal regulation in other words.
iv. Effective tax rate: The actual percentage of the income that is paid in taxes.
c. Explain in general terms why a company reports deferred income taxes as part of their total income tax expense. Why don’t companies simply report their current tax bill as their income tax expense?
The company reports the deferred income tax as a part of the income tax expense because it is a liability. If it was not included, their expenses would be deflated and their net income would be inflated. Companies do not report their current tax bill as their income tax expense because the total tax expense for a specific fiscal year may be different than the tax liability owed to the IRS as the company is postponing payment based on accounting rule differences(Investopedia.com).
d. Explain what deferred income tax assets and deferred income tax liabilities
represent. Give an example of a situation that would give rise to each of these items on the balance sheet.
“A deferred income tax asset represents a situation where there has been an
overpayment of taxes or prepaid taxes on its balance sheet. The taxes are eventually returned to the business in the form of tax relief, and the over-payment is, therefore, an asset for the company”(Investopedia.com). An example would be if the company prepaid their tax expense.
“A deferred income tax liability is an account on a company's balance sheet that is a result of temporary differences between the company's accounting and tax carrying values, the anticipated and enacted income tax rate, and estimated taxes payable for the current year. This liability may be realized during any given year, which makes the deferred status appropriate” (Investopedia.com). An example would be a company using depreciation like straight line or accelerated.
e. Explain what a deferred income tax valuation allowance is and when it should be recorded.
A valuation allowance is a balance sheet line item that offsets all or a portion of the value of a company's deferred tax assets because the company doesn't expect it will be able to realize this value(wikiinvest.com). Therefore, it would be recorded only when the company believes that there is probability in not realizing all or a portion of the value.
f. Consider the information disclosed in Note 8 – Income Taxes to answer the following questions:
i. Using information in the first table in Note 8, show the journal entry that ZAGG recorded for the income tax provision in fiscal 2012?
Debit: Income Tax expense $9,393 Debit: Net deferred $8239
Credit: Income Tax Payable $17,680
ii. Using the information in the third table in Note 8, decompose the amount of
“net deferred income taxes” recorded in income tax journal entry in part f. i.
into its deferred income tax asset and deferred income tax liability components.
Debit: Income Tax Expense $9,393 Debit: Deferred Tax Asset $8,002 Debit: Deferred Tax Liability $291 Credit: Income Tax Payable $17,68
iii. The second table in Note 8 provides a reconciliation of income taxes computed using the federal statutory rate (35%) to income taxes computed using ZAGG’s effective tax rate. Calculate ZAGG’s 2012 effective tax rate using the information provided in their income statement. What accounts for the difference between the statutory rate and ZAGG’s effective tax rate?
ETR=Tax expense/Pretax income= (9,393/23,898) =39.3%
iv. According to the third table in Note 8 – Income Taxes, ZAGG had a net deferred income tax asset balance of $13,508,000 at December 31, 2012. Explain where this amount appears on ZAGG’s balance sheet.
The amounts appear separately on the balance sheet. The deferred income tax assets total is $6,912. The other portion is a separately listed assuming a non- current deferred income tax asset total of $6,596.
Case 8: Build-A-Bear
a. Why do companies lease assets rather than buy them?
The equipment has lower upfront cost, the expense to lease can be used as a tax deductible, and you are able to have the option of the newest
equipment(smallbusiness.chron.com).
b. What is an operating lease? What is a capital lease? What is a direct-financing lease?
What is a sales- type lease? (Hint: If your textbook does not cover these lease complexities, use your favorite Internet search engine to find definitions and examples.)
Operating lease: “An operating lease is the rental of an asset from a lessor, but not under terms that would classify it as a capital lease” (accountingtools.com). An operating lease lets the company omit the assets from the balance sheet.
Capital lease: “A capital lease is a lease in which the lessor only finances the lease, and all other rights of ownership transfer to the lessee, resulting in the recording of the asset as the lessee's property in its general ledger”
(accountingtools.com). Because it is a capital lease, it can only record the interest as an expense.
Direct-financing lease: “A direct financing lease is a financing arrangement in which the lessor acquires assets and leases them to its customers, with the intent of generating revenue from the resulting interest payments. Under this
arrangement, the lessor recognizes the gross investment in the lease and the
related amount of unearned income” (accountingtools.com).
Sales-type lease:” A lease is classified as a sales-type lease by the lessor when the fair value of the leased property at the start of a lease varies from its carrying
amount, it involves real estate, and there is a transfer of ownership to the lessee by the end of the lease term” (accountingtools.com). If the lease does not have real estate, it is classified as an operating lease.
c. Why do accountants distinguish between different types of leases?
Accountants distinguish between leases because, depending on the classification, the assets could affect the liability portion or the asset portion on the balance sheet.
d. Consider the following hypothetical lease for a Build-A-Bear Workshop retail location.
i. Will this lease be treated as an operating lease or a capital lease under current U.S. GAAP? Explain. It would be treated as an operating lease because there is no transfer. If there was a transfer of the land, it would be a capital lease.
There is also no bargain purchase.
ii. Provide the journal entry that Build-A-Bear Workshop will record when it makes the first lease payment.
Debit: Rent expense 100,000
Credit: Cash 100,000
iii. Assume that a second lease is identical to this lease except that Build-A-Bear b Workshop is offered a “first year rent-free.” That is, the company will make no cash payment at the end of year one, but will make payments of
$125,000 at the end of each of years 2 through 5. Provide the journal entries that the company will make over the term of this lease.
Instead of paying unequal amounts, the cost should be an average cost of year 1 through 5 to get a uniform cost.
Debit: Rent Expense: 100,000
Debit: Deferred rent: 25,000
Credit: Cash: 125,000
e. Consider Build-A-Bear Workshop’s operating lease payments and the information in Note 10, Commitments and Contingencies. Further information about their
operating leases is reported in Note 1, Description of Business and Basis of Preparation (k) Deferred Rent.
What was the amount of rent expense on operating leases in fiscal 2009?
2009: 46.8 million
You add the rent expense and the contingents to get this number.
Where did that expense appear on the company’s income statement?
It appeared in SG&A and store pre-opening.
f. Recent proposals by the Financial Accounting Standards Board and the
International Accounting Standards Board would largely eliminate the option to use operating lease accounting. Most leases would be accounted for as capital leases
(which are called “finance” leases under IFRS). The present value of the expected lease payments would be treated as a “right to use the leased asset.” A corresponding capital lease obligation would be recorded, representing the liability incurred when the right- to-use asset was acquired. The asset would be amortized over a period not to exceed the lease term. The obligation would be accounted for as an interest-bearing
obligation. Consider the future minimum lease payments made under the operating leases disclosed in Note 10, Commitments and Contingencies. Assume that all lease payments are made on the final day of each fiscal year. Also assume that payments made subsequent to 2014 are made evenly over three years.
Calculate the present value of the future minimum lease payments at January 2, 2010. Assume that the implicit interest rate in these leases is 7%.
i. Had Build-A-Bear Workshop entered into all of these leases on January 2, 2010 (the final day of fiscal 2009), what journal entry would the company have recorded if the leases were considered capital leases?
Debit: PPE 219,644
Credit: Lease Obligation 219,644 Discount
Rate 7%
Period PMT
PV Factor
PV of PMT 1 $50,651 0.9346 $47,337 2 47,107 0.8734 $41,145 3 42,345 0.8163 $34,566 4 35,469 0.7629 $27,059 5 31,319 0.7130 $22,330 6 25,229 0.6663 $16,811 7 25,229 0.6227 $15,711 8 25,229 0.5820 $14,684
Total: $219,644
ii. What journal entries would the company record in fiscal 2010 for these leases, if they were considered capital leases? There are two: one to record interest expense and the lease payment and one to record amortization of the leased asset.
Debit: Lease Obligation 35,276 Debit: Interest Expense 15,375 Credit: Cash 50,651
Debit: Depreciation Expense 27,456 Credit: Accum. Depreciation 27,456
g. Under current U.S. GAAP, what incentives does Build-A-Bear Workshop, Inc.’s management have to structure its leases as operating leases? Comment on the effect of leasing on the quality of the company’s financial reporting.
Operating leases do not increase the liabilities; therefore, the current ratio would be higher.
h. If Build-A-Bear had capitalized their operating leases as the FASB and IASB propose, key financial ratios would have been affected.
Refer to your solution to part f, above to compute the potential impact on the current ratio, debt-to-equity ratio (defined as total liabilities divided by stockholders’ equity) and long-term debt-to-assets ratio (defined as long-term debt divided by total assets) at January 2, 2010. Is it true that the decision to capitalize leases will always yield weaker liquidity and solvency ratios?
Original Capitalized Current
Ratio 1.66 1.68
Debt to
Equity 0.73 1.84
Debt to
Assets 0.13 0.47
Capitalizing leases will not always yield weaker ratios based off of the ratios calculated.
Case 9: Rocky Mountain
Chocolate Factory
Chart of Accounts
Chart of Accounts (cont.)
Income Statement
Balance Sheet
Statement of Retain Earnings
Classification of Cash Flows
Jouranl Entries
Journal Entries (cont.)
Case 10: Income Statement
Presentation
Table of Contents
Executive Summary………. Page3 Iiii Analysis of Totz Income Statement Presentation……. Page Iiv
Net Sales……….. Page Iiv Gross Profit……….. Page lv Gain on Sale of Corporate Headquarters………. Page lvi
Class Action Settlement………. Page lviii
Executive Summary
Totz is a registered company with the SEC and “ has its year end on the Saturday closest to January 31st.” The 2016, 2015, and 2014 fiscal years ended on January 30, 2016, January 31st, 2015, and January 2014, respectively. The company manufacturers and has retail of “high quality and stylish children’s clothing.” Totz’ stores are very vibrant.
In Totz’ stores, there is also Doodlez, which is an art studio that was introduced in the third quarter of the 2015 fiscal year.
Analysis of Totz Income Statement Presentation Net Sales
Totz had an increase of $12 million dollars from fiscal year 2015 to fiscal year 2016. The increase was aided by the addition of the services performed by Doodlez, which had
$3.9 million revenue in fiscal 2015 and $11.2 million revenue in 2016. According to ASC 225-10-S99-2 in the FASB Codification, net sales is presented in the operating section of the multi-step income statement. The following is stated in the codification under ASC 225-10-S99-2:
“(a) The purpose of this rule is to indicate the various line items which, if applicable, and except as otherwise permitted by the Commission, should appear on the face of the income statements filed for the persons to whom this article pertains (see § 210.4–01(a)).
(b) If income is derived from more than one of the subcaptions described under § 210.5–03.1, each class which is not more than 10 percent of the sum of the items may be combined with another class.
If these items are combined, related costs and expenses as
described under § 210.5–03.2 shall be combined in the same manner.
1. Net sales and gross revenues. State separately:
(a) Net sales of tangible products (gross sales less discounts, returns and allowances),
(b) operating revenues of public utilities or others;
(c) income from rentals;
(d) revenues from services; and (e) other revenues.”
It should be noted in the footnotes or in a comparative income statement that the earnings from Doodlez was only from the third quarter the prior year.
Gross Profit
Totz had an increase of gross profit from $28 million in its 2015 fiscal year to $30.4 million in its 2016 fiscal year. The cost of sales included “expenses incurred to acquire and produce inventory for sale, such as product costs, freight-in and import costs, and direct labor costs for Doodlez' employees. Cost of sales excludes depreciation. In the cost of sales segment, there was an increase from $46.5 million to $56.1 million in the 2016 fiscal year. This was in most part due to the increase of the cost of Doodlez' services. The gross profit of the company is presented in the operation section of the multi step income statement. The ASU 225-10-S99-8 in the codification states the following about the exclusion of depreciation:
“Facts: Company B excludes depreciation and depletion from cost of sales in its income statement.
Question: How should this exclusion be disclosed?
Interpretive Response: If cost of sales or operating expenses exclude
charges for depreciation, depletion and amortization of property, plant and equipment, the description of the line item should read somewhat as follows:
"Cost of goods sold (exclusive of items shown separately below)" or "Cost of goods sold (exclusive of depreciation shown separately below)." To avoid placing undue emphasis on "cash flow," depreciation, depletion and
amortization should not be positioned in the income statement in a manner which results in reporting a figure for income before depreciation.”
The depreciation expense that was originally excluded from cost of sales must be noted in the cost of sales.
Section ASU 225-10-S99of the codification states the following about expenses:
2. Costs and expenses applicable to sales and revenues.
State separately the amount of (a) cost of tangible goods sold,
(b) operating expenses of public utilities or others, (c) expenses applicable to rental income,
(d) cost of services, and
(e) expenses applicable to other revenues.
Merchandising organizations, both wholesale and retail, may include occupancy and buying costs under caption 2(a). Amounts of costs and expenses incurred from transactions with related parties shall be disclosed as required under § 210.4–08(k).
The operating expenses from Totz and Doodlez both exceed ten percent and should be reported separately as cost of tangible goods and cost of services in the operating section under the cost of sales segment in the multi-step income statement.
Gain on Sale of Corporate Headquarters
Totz sold their original headquarters building and moved to a new building in Mountain View California. After selling the abandoned building, the company realized a gain of $1.7 million on the sale. This gain will be presented in the non operating section of the multi step income statement. In section 360-10-45-9, the following is stated:
“A long-lived asset (disposal group) to be sold shall be classified as held for sale in the period in which all of the following criteria are met:
a. Management, having the authority to approve the action, commits to a plan to sell the asset (disposal group).
b. The asset (disposal group) is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets (disposal groups). (See Examples 5 through 7 [paragraphs 360-10-55-37 through 55-41], which illustrate when that criterion would be met).
c. An active program to locate a buyer and other actions required to complete the plan to sell the asset (disposal group) have been initiated.
d. The sale of the asset (disposal group) is probable, and transfer of the asset (disposal group) is expected to qualify for recognition as a completed sale, within one year, except as permitted by paragraph 360-10-45-11. (See Example 8 [paragraph 360-10-55-43], which illustrates when that criterion would be met). The term probable refers to a future sale that is likely to occur.
e. The asset (disposal group) is being actively marketed for sale at a price that is reasonable in relation to its current fair value. The price at which a long-lived asset (disposal group) is being marketed is indicative of whether the entity currently has the intent and ability to sell the asset (disposal group).
A market price that is reasonable in relation to fair value indicates that the asset (disposal group) is available for immediate sale, whereas a market
price in excess of fair value indicates that the asset (disposal group) is not available for immediate sale.
f. Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.”
The company should use this section of the codification as a reference because of the criteria that their sell meets.
Class Action Settlement
Totz realized that the natural fiber they were using from their suppliers was not natural. In the 2016 fiscal year, Totz settled a class action lawsuit related to the legal case against the supplier and received $2.7 million. The gain from this settlement will be in the non operating section of the multistep income statement. Section 225-20-45- 16 states the following:
“A material event or transaction that is unusual in nature or occurs infrequently but not both, and therefore does not meet both criteria for
classification as an extraordinary item, shall be reported as a separate component of income from continuing operations. The nature and financial effects of each event or transaction shall be disclosed on the face of the income statement or, alternatively, in notes to financial statements. Gains or losses of a similar nature that are not individually material shall be
aggregated. Such items shall not be reported on the face of the income statement net of income taxes or in any other manner that may imply that t they are extraordinary items. Similarly, the EPS effects of those items shall not be presented on the face of the income statement.”